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EM Rate Hikes and Growth May Provide Currency Support

November 01, 2021

Read Time 2 MIN

 

Recent rate hikes across emerging markets (EM) reflect a broad tightening bias, while most developed markets (DM) continue to maintain low nominal rates and negative real rates. The market is currently anticipating further tightening across nearly all non-Asian economies as central banks react swiftly to inflation upside surprises, as well as higher than expected growth and improving labor markets. The benefit of maintaining substantial positive real yields is illustrated in the chart below. EMs went into the pandemic-driven recession with the policy flexibility to react, and they were able to cut rates aggressively to stimulate growth. As the recovery has taken hold, all of the easing that had been implemented has been erased. DMs did not have nearly as much room to ease rates, and have maintained other, extraordinary, expansionary policies, despite strong economic growth and signs of inflation.

Policy Rates in EM and DM

Policy Rates in EM and DM

Source: VanEck Research; Bloomberg LP
PPP GDP Weights: weighted average rate by GDP adjusted for different price levels in each country.

EMs do not have the same ability to tolerate higher than normal inflation, and for the last two decades have kept a closer eye on financial stability concerns, given their dependence on external funding. Central bankers have remained vigilant amid high inflation readings, maintaining their credibility and reliance on conventional monetary policies to keep inflation expectations in check. As is the case globally, price pressures have largely been supply-driven. In addition, many EMs are experiencing strengthening demand, as the growth recovery has been stronger than anticipated. While higher inflation in EMs has certainly detracted from EMFX returns so far this year, higher growth and the swiftness of central bank action may provide support going forward. Further, the rate differential between EM local currency bonds and U.S. interest rates, which was nearly at the lowest level in a decade going into the pandemic, has increased significantly this year.1 In nominal terms, the yield differential has moved out to approximately 4.1 percentage points, from 3.6 at the beginning of the year, and 3.4 at the beginning of 2020. This increased buffer provided by market interest rates may also help provide support for currencies, in our opinion.

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DISCLOSURES

1 Source: J.P. Morgan as of 9/30/2021, as measured by the yield difference between the J.P. Morgan GBI-EM Global Diversified Index and on-the-run 7-Year U.S. Treasury.

Please note that VanEck may offer investments products that invest in the asset class(es) discussed herein.

J.P. Morgan GBI-EM Global Diversified Index is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.

ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index tracks the performance of US dollar denominated below investment grade emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.

This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed in this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

All investing is subject to risk, including the possible loss of the money you invest. Bonds and bond funds will decrease in value as interest rates rise. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.

DISCLOSURES

1 Source: J.P. Morgan as of 9/30/2021, as measured by the yield difference between the J.P. Morgan GBI-EM Global Diversified Index and on-the-run 7-Year U.S. Treasury.

Please note that VanEck may offer investments products that invest in the asset class(es) discussed herein.

J.P. Morgan GBI-EM Global Diversified Index is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.

ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index tracks the performance of US dollar denominated below investment grade emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.

This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed in this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

All investing is subject to risk, including the possible loss of the money you invest. Bonds and bond funds will decrease in value as interest rates rise. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.